College tuition costs

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Deducting college expenses

Prepaid tuition (529) plans

College savings (529) plans

Using UGMA/UTMA accounts

Loans & interest deductions

Qualifying for student aid

Tax credits for education

Education savings bonds

Education Savings Accounts

Other IRAs & 401(k) plans

Room-and-board options

Grandparents & other sponsors

Deducting college expenses

The money that you invest in yours, your spouse's, or a dependent's higher education translates into direct tax savings. The tuition tax deduction is an above-the-line deduction. This means you don't have to itemize or limit the deduction.

The following table calculates the tax savings and future value for two investors. One investor is in the 12% tax bracket. The other investor is in the 22% tax bracket. Both investors can earn a 5% rate of return. Future value is calculated for a five-year period for a taxable and tax-exempt account.

Value of $4,000 tax deduction for 12% and 22% tax brackets:

Tax bracket:12%22%
Adjusted gross income:$30,000$55,000
Qualified expenses:$4,000$4,000
Tax savings:$480$880
Savings interest rate:2%2%
Future value (5 years):----
Tax-exempt account:$530$972
Taxable account:$524$951

If you are in the higher bracket, $4,000 in deductions saves you $880 in taxes this year. Invested in a tax-exempt account at 5% compounded yearly, this amount grows to $972. Invested in a taxable account at 5%, it grows to $951.

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.

Next, we'll take a look at prepaid tuition plans. These plans allow investors to pay college tuition in advance for their children or other beneficiaries.

Next Topic: Prepaid tuition (529) plans
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